Ending Accidental Time Bias
Author
Nigel Lake
Title
Ending Accidental Time Bias: A new approach to evaluating risk/return trade-offs.
Synopsis
Traditional discounted cash flow methods add a risk premium for risk and uncertainty. This emphasises the short term, leading to “accidental time bias”, and accentuates perceptions of unacceptable risk/return trade-offs. Pottinger’s approach utilises advanced statistical techniques to quantify explicitly the effects of risk and uncertainties on all project outcomes, and allowing a full range of realistically likely outcomes to be assessed. Explicit risk modelling allows us to use significantly lower discount rates (as used in conventional optional pricing techniques). Our approach thus avoids accidental time bias and provides a more complete risk/return picture. This approach thus allows project proponents and investors to attribute proper value to the longer run impact of proposed investments, as well as to take proper account of long run downside risks. As a result, more informed decisions can be made regarding overall project design, as well as in relation to optimisation of project funding and financing, and associated capital structures. These methods also provide a more effective framework for assessing social impact, as projects that are beneficial for society frequently translate into economic and financial benefits over longer time horizons.